Thursday, 22 December 2016

SA Q'n'A

The investor site 'Seeking Alpha' approached me for my thoughts on 2017. I was delighted to respond but felt as though I wasn't much help as I still believe it's too early for huge conviction trades, so please don't go through this post looking for 'get rich quick' nuggets of instruction. Hovever, it does give a feel of my current mood.

After a long and winding 2016, we reach another holiday season. As we have done for several years, we are checking in with some of our top authors for their views on the coming year and beyond. Our panel includes experts on a range of different asset classes and investing strategies. As always, the focus is on an overall approach to portfolio construction and investing outlook.

We continue this series with Polemic Paine, an inimitable voice on the markets who doesn't consider himself an expert, but a sanguine cynic towards beliefs peddled by others for their own benefit. He also believes in building up one's own framework of economic, trading and personal values from first principles and experiences. A nice companion piece to this one is his recently published article, A Guide To Making 2017 Financial Market Forecasts.

He responded to a few questions from Seeking Alpha Editor Rena Sherbill about the markets and what investors should look for in 2017.

Polemic Paine (PP): Focusing on behaviour rather than the maths. Mean reversionist against consensus doom or boom moods. Looking to buy in the darkest hours and sell in the brightest.

RS: As we approach 2017, are you bullish or bearish?

PP: In every meme you can find an asset for which the meme is bullish and equally as many for which it is bearish. As we approach 2017, I am neither bullish nor bearish on stock indices and do not want to be heavily positioned in much at all right now. For bonds just swing that view in reverse, but as I am neutral on those too I am doing nothing. I am waiting for the next panic to buy on or euphoria to sell into.

I don't think we have either at this point though I do detect an assumed conviction in the market as to what a new Trump world will actually mean, though these arguments are mostly extrapolations of guesses. So, if anything, I would be looking to sell US equities rather than buy. But not yet.

RS: To which index or fund do you benchmark your performance?

PP: None, other than absolute return. Benchmarks are an excuse to lose other people's money. Benchmarks are buck passing exercises that pass the investment decision back to the investor. The only benchmark anyone really cares about is absolute return. Risk adjustment is fine for the present as knowing what your risk IS important, but when you look back in time you don't give a damn what your risk WAS, all you care about is what it returned.

RS: What is your highest conviction pick heading into the new year and why (can be a long or short idea)?

PP: Now is too early to be convinced of any market trend. My highest conviction trade is that the first moves of January will be the wrong ones and worth fading. The Trump reflation trade is this year's consensus conviction trade and it will only gain further traction through feedback reinforcement as institutions publish their 2017 'trades of the year.' If we look back over the past few years there has been a tendency for the market to come crashing out of the new year starting gates and throw money behind these themes.

This drives prices that reinforce the belief that the trade is correct, only to see them crash and burn and be totally wrong by March. January 20th(ish), or first expiries, has often been a turn date and this year that date is even more important with Trump's inauguration speech. If you are looking for something more tangible on the markets in 2017, I am pretty convinced that a major speculative attack on Europe will occur. I just don't know at what time or on which day.

RS: Which domestic/global issue is most likely to adversely affect US markets in the coming year?

Global - US international relations, specifically with Russia and China. It is worth watching Turkey in this respect as it is where many political interests meet. I also consider that a speculative attack on Europe could become contagious to US assets.

RS: Which countries/sectors/asset classes are you currently most bullish on and why?

PP: As mentioned before, I am not at a high conviction level towards anything at the moment and think it unwise to be so until we have more information about what the future policy rules will be. But if I have to be bullish on something let's try...

UK - Despite the outcry over Brexit, the UK economy is still outperforming much of Europe and the rest of the world. I have been long GBP for a few months now and still feel that the UK will end up with a soft Brexit. The biggest threat to UK growth may not come from Brexit, but a cut in US corporation tax which would see the UK's global competitive advantage for capital squashed.

Emerging Markets - Traditionally we have an emerging market crisis in January / February but it's been kicked off early this year by Trump and his promised protectionist policies. However, protectionism will only drive the cost differential between EM and the US wider and though you may think that you'd like to pay minimum wage in the US for plastic goods to be made, when the realisation that that is 20 times as much as many places in the world, your moral compass may be interfered with by the cash magnet in your wallet. While someone is willing and able to do your job for less than you, you are in trouble. Artificial trade barriers may be a short-term solution but the fluid dynamics of trade mean that new routes will be discovered to give the consumer the goods they demand at the cheapest price.

RS: For investors with a long-term horizon and a reasonable risk tolerance, what is the correct mix between [relevant] asset classes?

PP: 60/40 for the simple fact that it has consistently worked. The real point here is that asset class performance is more governed by the investment within that class than simply by asset type. There are equities that behave like bonds, look at European infrastructure projects, and there are bonds that behave like equities, look at high yield, low credit, corporate bonds. We haven't even mentioned Cocos.

The key is not so much the correct mix of assets by bond/equity/commodity/country, etc. but how the selections are made within those portfolios. A bond portfolio can weather down drafts if it is all placed in very short duration bonds (cash is effectively a zero coupon perpetual bond) and the same with equities by utilising sector plays.

RS: How have potential changes to the tax code affected your assessment of interest-paying investments?

PP: They haven't. As I am UK-based I am pretty immune to the vagaries of local US law.

RS: What advice would you give to a 'do-it-yourself' investor looking at [xyz] opportunities in the present environment?

PP: Read books on behavioural economics. Assume that any data you know everyone else knows already (otherwise it would be inside trading). In today's algorithmic-driven markets you will never be the first to act on a piece of data. Classic analysis is always in the price. Look for an edge and nowadays it is nearly all behavioural. Understand what makes others buy and sell, the more you understand about the drivers of different types of investors the more likely you are to predict and anticipate their behaviour. The easiest way to lose money is to be a do-it-yourself investor who knows slightly less than everyone else. You will become the market's next meal.

RS: What are the major catalysts for markets in 2017?

PP: Politics. Whereas the last few years markets have been focused on predicting the minutiae of central bank policy, there are now bigger issues at work. It's all well and good to play games when you know what the rules are, but the rules are changing and are as yet unknown. So, focusing on politics I would suggest Trump's inauguration address on January 20th, Russia/US relations, Turkey, European elections and cartel deals (OPEC).

However, and this is a big however, there was very good money to be made in 2016 by buying the political risk into the event and then selling the market risk (i.e. buying risky assets in the markets) immediately afterwards as political risk was underestimated and the resulting damage to the markets of the outcomes overestimated. This may well have been learned, so the likelihood for 2017 is that political risk will now be overpriced.

RS: Which asset classes are you overweight? Which are you underweight?

PP: As mentioned above, generalising asset classes is a bit of a red herring. I am longer cash than normal as there are too many unknowns; however, I am scaling into long emerging market positions (equity and bond, unhedged FX) and I am particularly interested in Mexico, Korea and South American commodity countries.

RS: Any additional considerations you'd like to share with readers as they ponder their investing strategy in 2017 and beyond?

PP: Be nimble. New information is constantly appearing and trying to predict where we will be in year's time is a fool's errand. The most important thing is not to be sucked into the game of thinking that the 30th of December is a magical date at which one-year forecasts and investments have to be made. If you really want to put a forecast out on what to do for 2017 I recommend waiting for March. Doing otherwise, as most investment banks have found out, is asking for trouble.

Finally, the most important thing of all is to listen to as many people from as wide a background as possible. Do not fall for the reinforcement bias of surrounding yourself with people who think like you. This was the error that led to so many being shocked at the outcomes of Brexit and Trump. For most people it was not a surprise; they were the majority that voted for them.

2 comments:

Thanks Pol, good advice. Particularly the way you keep pulling them up on this idea that time has to be divided into discrete units, and a change of unit means you should have a change of view, change of opinion, change of lifestyle. (Similarly with New Year resolutions: why wait?)CheersChris

Totally agree with your view. In the modern days of instant gratification, it seems like the biz news reporting is skewed by the same notion that one has to be moving the money around at all times. Can we just stop and think for longer than just a moment, please? I constantly have conversations with other traders who can't quite grasp the idea that being flat is a position too. It's the end of the year, quarter, month. Moreover, it's the end of the easy Fed money and Obama's administration. There is a definite gap in action here, digestion of what is gone and what is still to come. That being said, I have put a few feelers in the market (eased into transports, semis, and copper shorts), thinking that I should follow my view of a pullback in January and the cyclical nature of Trumpflation trade which is nothing more than a blind faith right now. But with lower level of conviction and the fact that I am shorting tops here (i.e. pissing against the wind) my positions are so small that I am considering myself being flat at the moment. I will add to them as the things become somewhat clearer.